Business Insight 27th Jul 2015

Hidden cost of overregulation

The threat of inspection and penalties imposed by the corporate regulator has driven audit firms to adopt more of a 'check-list' approach to their work than has been used in the past. This reduces the extent of varied professional experience in the auditors' dealings with clients, research by Professor Robyn Moroney has found.

The Australian Securities and Investments Commission's (ASIC's) strengthened investigative powers, coupled with the threat of harsh penalties for breaches of auditing standards and laws, has driven large audit firms to develop more standardised approaches and has also altered their approach to staffing audits.

Professor Robyn Moroney, says the changes have led ASIC to become a more influential participant in the auditing sector, rather than a passive monitor and observer.

Auditing

"What we're seeing is firms having a more structured 'check-list' approach to dealing with audits. Much of the more creative, individualised approach is being lost. This has the potential to impact the way financial statement audits are conducted in the future," she says.

The regulatory changes have enhanced audit quality but they have also altered audit firms' staffing and workplace environments – an issue that could have long-term effects for the industry. 

"We are seeing audit firms allocating more senior staff and better performing staff to clients they think are more likely to be inspected by ASIC. This is creating an uneven spread of expertise across different clients," Professor Moroney says.

Moving forward

In the future, audit firms may potentially select 'process-driven, detail orientated' people rather than more creative, abstract thinking employees. This could change the face of the profession, Professor Moroney says

Both process-driven people and creative thinkers are important to the profession. Firms need to ensure they reward all types of people with different skills sets. We don't want to lose differently skilled auditors. The risk is that the profession could change as a result of stricter regulation.

Professor Robyn Moroney

Department of Accounting

ASIC too has acknowledged the growing staffing inefficiencies within many audit firms. In its audit inspection findings for 2012-14 (released in June 2014), the regulator encouraged firms to consider reviewing their staffing structures to "ensure that sufficient and appropriate experience and expertise is available for increasingly complex entities and audits that require significant judgments". It suggested access to relevant experts also needed to be reviewed. 

ASIC's inspection findings for the period found that in 20 per cent of its specified "key audit" areas, auditors failed to obtain reasonable assurance that financial reports were free of misstatements. However ASIC acknowledged that, at the time of review, some of the changes made by audit firms to their processes had not yet filtered through.

'While audit firms have made good efforts to improve audit quality, these are yet to be reflected in our… findings," ASIC Commissioner John Price said. "Auditors are gatekeepers that play a critical role in ensuring that Australian investors can be confident and informed. It is important to continue the work to improve audit quality and the consistency of audit execution."

The unforeseen effects of over-regulation are well documented in Australia. The introduction of the Financial Services Reform Act (2001) dealt with some systemic problems in the general insurance sector following the $5.3 billion collapse of HIH Insurance in 2001. 

While the regulations had a somewhat cathartic impact on the industry, removing some smaller, inefficient businesses, it substantially increased the compliance costs of the remaining players, causing confusion for policyholders and companies, and in some cases led to higher premium rates for consumers. ASIC continues to work with the professional services sector to improve its regulatory framework and its execution. 

"What has been recognised is there needs to be a balance between accountability and regulation and allowing auditors to do their job."

International impact 

Monash Business School's Department of Accounting research is having an impact on international audit regulation. The International Auditing and Assurance Standards Board (IAASB) is changing the format of audit reports and has sought feedback on its changes.

In 2013, Professor Robyn Moroney, Dr Wei Lu, and Dr Stephen Smith conducted an experiment with Monash students as participants. Their findings were submitted to the IAASB, who took on board the findings when formulating the final structure of audit reports in the future.

By Jane Lindhe

  • Professor Robyn Moroney

    Professor Robyn Moroney

    Department of Accounting

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